Real Estate Chronicle

A blog dedicated to real estate matters, finance as well as general economics and political economics issues. Posts written by Luigi Frascati, B.Econ. Your comments and suggestions are appreciated.

Wednesday, June 28, 2006

Oil and Real Estate

As price of crude has topped the USD $70 per barrel landmark, will stock market woes spill into and affect the real estate market?

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There are some real differences between the workings of the stock market and those of real estate. At its core the housing market, like the stock market, is all about supply and demand. However, the difference is that stocks and bonds investors base their decisions to buy into stocks on future potential, whereas real estate investors base their decisions to buy into housing on inherent value. Thus, the type and quality of demand exercised buy a stock purchaser is very much different from the type and quality of demand of a real estate buyer. Because stock investors characteristically place their bets on future potential, Wall Street is an excellent – the best, in fact – gauge of things to come, a thermometer of the future.

Wall Street, these days, seems to be saying that the future holds unpleasant surprises.

When the economy as a whole is put under the double pressure of increasing interest rates and increasing oil prices, the escape of capital towards the payment of interests and the purchase of oil and related products is to be felt on general demand for goods and services, which include both the stock market and real estate. Wall Street is invariably more sensitive to economic imbalances and their repercussions, because stock trading is a faster market than real estate, by far.

Supply threats in major oil producing nations like Iran, Nigeria and Iraq have pushed US oil futures to USD $69 per bbl., within striking distance of the all-time high USD $70.85 per bbl. hit last August, after Hurricane Katrina leveled U.S. oil platforms and refineries. Iran is at odds with the West over its atomic program, rebels have knocked out nearly a quarter of Nigeria's output and Iraq's exports are at their lowest since the U.S.-led invasion. Moreover, continued growth and strong demand for oil in the United States and China - the world's two largest energy consumers - is also adding to concerns that the oil industry may struggle to match voracious consumption, thus pushing crude prices even higher.

As oil becomes scarcer and more expensive, there is a high probability that the economic shock waves will hit hard throughout the economy. Petroleum is a basic raw material used in the manufacturing of many products including chemicals, paints, plastics and synthetic textiles. Other industries - steel, aluminum, power generating plants - use large quantities of oil and oil derivatives in the course of their production. When petroleum supplies become pinched and prices push up, these industries may well be forced to restrict output and raise prices, thus putting even more inflationary pressure on the economy. These, in turn, may force central banks to adjust their monetary policies by raising interest rates higher and, what’s worse, faster, thus not giving enough time to the economy to adjust. Scarcely any enterprise is immune to the oil squeeze, as the lessons of the ‘70’s and the ‘80’s have taught, and real estate is definitely no exception.

Obviously, it is hard for stocks to take off with oil going straight up to the US $70 a barrel, or when the Fed keeps saying interest rates are going to go higher. And every day, people putting more money towards maintenance of their debts and towards the purchase of ever expensive consumers goods means less people putting money into stocks and bonds or, for that matter, real capital assets. Besides, as interest rates increase, mortgage funds erogated by lenders dwindle, because they too become more expensive and out of reach or, otherwise, unaffordable. The real estate industry has been booming as housing prices have soared. But if interest rates continue to rise, new borrowing against home equity will drop, and may disappear. If all that borrowing - which freed up cash that was spent on new furniture, appliances, vacations, cars and the like - simply vanished, the effect could be large enough all by itself to send the economy into recession.

At stake there is what we economists refer to as “The Wealth Effect”. Consumers tend to spend more when their net worth increases, and less when it decreases. When people feel rich, they spend - a psychological effect known in Economics as "The Wealth Effect". It doesn't matter whether their wealth is actual or merely on paper, whether the money they spend is their own or borrowed on the equity of their assets. Economists use this rule of thumb: a $1 change in household wealth leads to a roughly 5-cent change in consumer spending. Consumers have felt rich – very rich – these past few years. So rich, in fact, that real estate purchasers, for example, have lined up to buy properties always more and more overpriced.

Why did they do it? Afterall, everybody knew that the market was overpriced, that it was ‘hot’, that it was a Sellers’ market. I can personally attest to the fact that several times last year, when I took people out shopping for houses and apartments, it was very common to hear comments the likes of “Oh my God!” or “That’s too much!” or “It’s not worth it!” And yet, the same people who were making those remarks ultimately ended up buying – at Sellers’ prices, in fact, if not more. So, again, why did they do it?

The answer is to be found in the ratio of the perceived value of a capital asset vis-a-vis its intrinsic risk of acquisition, the so called ‘worth’. Clearly the lower the risk, the higher the perceived value and its worth. It follows, therefore, that the perceived value – or simply ‘value’ - of a real capital asset is the total monetary worth obtained by reducing exposure to risk and liability. Put in elementary terms, ‘value’ is the total net benefit a buyer expects to receive from a purchase, measured in currency. And in times of expansion, like the ones we have seen in real estate, risk was perceived as minimized because of the appreciation of property values, coupled by the relatively low cost of borrowing. Now that the tide is changing direction, sellers must apply leverage on the perceived value of the interest in land they are offering in order to motivate buyers, and there is no better way to accomplish that than by lowering prices.

It all boils down to prove, therefore, that oil is so important for real estate, that the impact of an energy crunch may be felt and engulf the entire industry in addition, of course to spreading throughout the entire economy. In fact, it may affect our very own way of living.

Sunday, June 25, 2006

How To Spot A Grow-Op

BUYERS BEWARE! Sure signs that a house has been used for home-based marijuana growing operations.

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The number of marijuana grow-ops and drug seizures has dramatically increased over the last few years.

There are many other serious community consequences associated with these crimes. Marijuana grow-ops are continuously linked to property crimes and crimes of violence. In addition to finding stolen property inside these homes, Police have investigated several home invasions where thieves have broken into grow-op houses to steal the marijuana crop being produced. Some recent home invasions involved innocent families that had moved into a previous grow-op house or were living close to one and were mistakenly victimized. It is important, therefore, to spot a grow-op and report any suspicious activity to the authorities.

The following are characteristics of typical grow-op houses, many effects of which can still be visible after the house has been vacated:

[ ] There are dark coverings over some of the windows to prevent the escape of bright hydroponic lights.

[ ] Rooms in the house or outbuildings seem to be illuminated all the time.

[ ] There is heavy condensation on the windows. Absence of frost or snow on the roof when other houses have frost or snow. Or growers put fans in the window to increase air circulation that blows the curtains around.

[ ] There may be an unusual number of roof vents, or unusual amounts of steam coming from vents in cold weather.

[ ] A variety of extra measures have been taken to protect the house, i.e. new fencing, guard dogs, bars on the windows etc. Entry is exclusively through the automatic garage doors. Residents are hardly ever seen out of their cars.

[ ] There is a strange odor emanating from the house (pungent and skunky).

[ ] Sounds of electrical humming, fans or trickling water. There are also construction noises associated to accommodate a marijuana production facility.

[ ] There is unusual or modified wiring on the exterior of the house.

[ ] The hydro meter can be seen spinning unusually fast. Growers have most of their lights on for at least 12 - 18 hours at a time.

[ ] Localized power surges or browning - neighborhood residences or units experience unexplained power surges or decrease of power that dims lights and slows down appliance use, with the return of normal power flow about 12 hours later.

[ ] Residents avoid all contacts with neighbors.

[ ] Children’s toys and bikes are left outside but there are no children seen at the residence.

[ ] Quantities of growing equipment and supplies are seen to be taken into the house, shed or garage, yet there are no flowers or garden at the house. Often these supplies are purchased in winter.

[ ] There are pots, soil, hoses and nutrients scattered around the property.

[ ] The house can appear to be vacant, the yard is not well-tended, and flyers are accumulating at the door. Residents are seldom seen (garbage is rarely put out to the curb).

[ ] There are hoses running from doors or windows on the exterior of the house.

[ ] Instances of visitors parking down the street and walking to the house. There is excessive vehicle and/or pedestrian traffic day or night at unusual hours.

[ ] The occupants appear to have moved in at night.

[ ] It is never possible to see activity at the house but there is lots of garbage.

There are in Italy some 22 political parties and affiliations of all colors, shapes and forms reflecting all lines of philosophical thinking and social doctrines ever pipe-dreamed by humans since the time Homo Erectus decided to step out of the African plains and conquer the planet. Italy is the only one country in the world where Fascists sit side by side with Maoists in the same parliament. Heck, you can still find Trotskyists in Italy even today – after they have been banned from Russia since the 1930’s.

To make matters somewhat more manageable, in the mid-1990’s it was decided to form five mainstream political ‘coalitions’, each representing the best interests of the myriad political parties that each coalition is comprised of. The coalitions are: Forza Italia (literally ‘Go Italy’), Alleanza Nazionale (National Alliance), Lega Del Nord (Northern League), L’ Unione Democratica Cristiana Di Centro (Union of Christian Democrats of the Center) and L’ Unione Di Centro Sinistra (Center-Left Union).

To make matters even more manageable (whoever said Italians are difficult?), so that everyone can fully understand what is going on in Italian politics, two mainstream political ‘currents’ comprising of the above-noted five mainstream political ‘coalitions’ were formed: La Casa Della Liberta’ (literally ‘The House of Freedom’) representing Go Italy, National Alliance and Northern League, and L’Unione (’The Union’) covering the bloc of the Union of Christian Democrats of the Center and the Center-Left Union.

Let’s face it – it couldn’t possibly get more transparent and crystal clear than this!

Since 2000, The House of Freedom has been headed by Silvio Berlusconi, a graduate summa cum laude in Business Advertising from Milan State University and the richest man in Italy who, with cash and assets worth some USD $12.5 billions (with a “b” as in ... “Berlusconi”), is the 23rd richest man on the planet. On the other side, The Union has been represented by Romano Prodi, a graduate summa cum laude from The London School Of Economics, a former Visiting Professor at Harvard, a Fellow of The Stanford Research Institute, and the former President Of The European Commission.

To say that Prodi, by virtue of his background as an Economist, has always eyed Berlusconi’s economic theory that “lowering taxes and raising pensions is great for the country” with a great deal of skepticism, is probably an understatement per se. But this must have turned into outright despair when Italians voted The House of Freedom into power in the 2001 elections, and Berlusconi became President Of the Council of Ministers (Prime Minister). And the despair must have turned into outright horror when Italy posted in 2005, four years into Berlusconi’s tenure, a GDP of 0 percent for 2004 (that's 'zero' ... as in 1 minus 1) - a record in the West. Well, it could have been worse.

To be sure, a miracle has happened during Berlusconi’s residence in Rome. In 2004 Berlusconi, a bald man, turned up on TV looking like Elton John, and prompting the Romans to flock and head straight for St. Peter’s Square chanting Miracolo, Miracolo (“Miracle, Miracle”). But for the Americans, Berlusconi’s exuberance will more likely be remembered when, all the way back in 2002 during his first official trip to Washington as Italy’s Prime Minister (Berlusconi owns several real estate holdings in the U.S.), Berlusconi stepped out of the airplane and went straight to greet an incredulous President Bush with a vigorous handshake, literally screaming in his ears Ciao, Giorgio! (“Hi, George”). The twosome must have hit it off, because they have been great pals ever since.

The world will possibly remember Silvio Berlusconi as one of the most outspoken – albeit apolitical – national leaders ever, although his picturesque remarks have not always won him the praise, sympathy and affection of fellow leaders. Such is the case when he called Robert Mugabe of Zimbabwe an “Orangutan” for his controversial polices of redistributing white-owned landholdings to poor Zimbabweans, or King Fahd of Saudi Arabia Il Becchino (”The Gravedigger”) for his forceful opposition to Israel. And member countries of the European Union will remember Berlusconi for his 2003 address in Bruxelles, when he countered German criticism and objections to Italy’s chronically unbalanced budget by calling the German delegation “a bunch of Nazis”, thus prompting a great deal of chuckling on the part of the French (another country with a perennially unbalanced budget).

On the accounts of religion and philosophy, it cannot be said that Berlusconi has scored big time either. A great admirer of Gandhi, he stated that “Gandhi was a better person than many Popes”, thus raising a sequel of criticism from the Holy See. The criticism mounted last year, when Berlusconi remarked at the funeral of John Paul II that he (the Pope) had been “one of the few great Popes”. And just very recently, in the heat of this past elections, he has claimed that “Chinese communists eat babies for dinner”, generating an outcry on the part of Beijing, or when Berlusconi compared himself to Jesus Christ.

Yet, it is possibly because of his flamboyant nature and irreverent style that Silvio Berlusconi will be missed by many. Notwithstanding his USD $12.5 billions, Berlusconi was, is and always will be a man of the people, and will be remembered as such. No matter that his economic policies only made him richer, and nobody else. It is the dream that counts – and Silvio Berlusconi has been the only man since the institution of the Republic that has made Italians dream for five consecutive years. Nobody else has lasted for so long – and in Italian politics that’s a real record.

Monday, June 19, 2006

Grow-Ops!

The economic impact on the real estate industry of home-based marijuana growing operations.

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Here is another very good reason to quit smoking: home-based marijuana growing operations not only reduce the market value of the properties they are carried out into – they also inhibit market values of neighboring properties as well! This is so, because most grow-ops are controlled and run for the benefit of organized crime, and these types of activities attract a lot of thugs who tend to fill the neighborhood at odd hours, so that the charm of home-sweet-home all of a sudden changes drastically for the worse. The Organized Crime Agency of British Columbia says that organized crime controls 85 percent of the marijuana cultivation and distribution in B.C. You might as well as live next to Sing-Sing.

In addition to spectacular natural scenery, super natural places to discover and two bustling metropolitan centers like Vancouver and Victoria, as well as boasting one of the mildest climates in Canada, British Columbia holds one other record – although this one is very seldom publicized on tourism websites: it is home to the ‘B.C. Bud’, one of the most sought-after varieties of marijuana.

Marijuana cultivation accounts for up to five percent of Canada’s GDP in British Columbia alone, which means that the crop is worth more than the local mining and logging industries combined. In 2004, there were an estimated 17,500 grow labs in British Columbia, producing pot worth up to CAD $7 billion. The number of grow-ops busted by Police in British Columbia more than doubled between 1999 and 2004, from 1,251 to 2,908.

To think that legalization or decriminalization would change anything is absolutely ludicrous, in Canada at least, since what is produced in Canada is destined for the United States. A pound of marijuana in British Columbia is worth about CAD $2,500 locally. That same pound of marijuana in Seattle can fetch up to CAD $7,500. Organized crime recognizes that. Because of this, the problem is getting bigger, not smaller, and it is impacting more and more the local residential real estate industry.

At the level of the individual property owner, grow-ops cause in many cases irreversible structural damage. As these properties are invariably rented by growers for several months and then abandoned, in many instances the homes have holes in the walls for vents to get rid of much of the moisture, concrete foundations are damaged to accommodate rewiring that may be required to steal electricity to run the operation, and the artificial high humidity level and heat generated by the 1000-watt lamps employed in the operation, as well as the chemicals used to grow marijuana faster, cause toxic mould and structural damage to the inner components of the walls (so called ‘black mould’). Besides, indoor grow-ops also pose a serious fire hazard, because marijuana cultivation requires much more electricity than a typical residential home. Illegal electrical hookups pose a serious safety risk for those in and near the home.

Human health risks can result from the mould sometimes associated with marijuana hydroponic cultivation, the chemicals used to foster plant growth, and the relatively high concentration of carbon dioxide and carbon monoxide suspected to exist in some grow-op dwellings. Many of these safety concerns are exacerbated by the fact that grow ops are generally located in high-density areas.

In addition, property owners must contend with the stigma - the consequence of an unusual, distressing event or circumstance such as a criminal activity - that attaches to properties formerly used for pot farming. This is especially evident when time comes to sell, as stigmatized properties are worth less because Buyers are reluctant to consider them. Prior to entering into a Contract to sell real estate the Seller is required to disclose to the Buyer any latent defects the Seller is aware of. Failure to disclose will not affect the consent of the parties, but will have similar consequences as misrepresentation. Likewise, Buyers who fail to disclose to a lender that the property they are about to purchase (with the lender’s money) has been used for marijuana growing commit a criminal offence under Section 380 of PART X (FRAUDULENT TRANSACTIONS RELATING TO CONTRACTS AND TRADE) of the Criminal Code.

And finally, with the increasing number of new homes and condominiums being used for marijuana farming, the companies who offer home warranties in British Columbia have begun suspending coverage on homes identified as grow-ops. Since 1999, all residential builders in B.C. must arrange for home warranty insurance before they can obtain a building permit. The legislated home warranty insurance covers two years on labor and materials, five years on the building envelope and ten years on the structure. But homes that have been used for purposes "other than residential" can have exclusions to their warranty. Since the houses are invariably damaged by the moisture, mould, bad wiring or other alterations made for a grow operation, companies that provide the warranties are sending inspectors to the homes, and then suspend coverage in whole or in part.

Thursday, June 15, 2006

This HUD's For You

A complete guide to HUD homes for sale.

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There is a brand new complete HUD homes Buyer's Guide out there entitled ‘HUD HOMES FOR SALE', which I have been fortunate enough to be called upon to review. It is in the form of an e-book and authored by Frances Flynn Thorsen, a Real Estate Agent of 22 years and HUD specialist.

This is the best guide covering the topic of HUD I have ever read, by far. And it is also the only one I am aware of written with the best interest of consumers in mind. The e-book consists of 112 pages covering each and every aspect of HUD transactions, from qualifications standards to FHA financing and underwriting guidelines. It is jam-packed with helpful hints and tips on how to select an Agent that specializes in HUD homes, all the way to determining how low should one go with the offer, and still get it accepted.

But perhaps most impressive is the writing style that Frances Flynn Thorsen uses throughout the e-book: succinct and to the point, so that anyone can easily and quickly grasp the concepts at hand. This work is written specifically for those Buyers, whether owner-users or investors, who mean business. Her no-frills approach is refreshingly welcome and useful. Moreover, as the procedures for handling HUD homes constantly evolves, Frances goes the extra step to update changes on a website specifically devoted to this book. So, in essence, one buys not only the comprehensive Guide but also all the future updates as well, as and when they come.

HUD HOMES FOR SALE is a user-friendly Guide also for all those non-American investors who are not particularly fond, for good or bad, of the way the United States Department of Housing and Urban Development handles business. Additionally, as Author Thorsen points out very clearly, any qualified Buyer can purchase HUD homes. This is of great interest particularly for Canadian investors, considering the prolonged slide of the American Dollar vis-à-vis the Loonie, which has made the American real estate landscape look already especially attractive for Canadians.

But irrespective of their origins, with HUD HOMES FOR SALE Buyer's Guide in hand all investors can now get into the HUD homes buying process with no fear of lack of knowledge or competence. More particularly, all those overly-cautious purchasers who make it a point to gather every scrap of information about potential investments - and who miss some great opportunities while trying to decide which ones are the great opportunities along the way - need to worry no more. HUD HOMES FOR SALE is the roadmap to success in HUD investing, laid out right in front of their very own eyes.

And last, but not least, a consideration about the price: at USD $19.95 per e-copy, this is a super investment all and by itself. It will save Buyers several hundreds of dollars in lawyers' consultation fees, and the result is going to be definitely more thorough, focused and to the point.

HUD HOMES FOR SALE can be purchased online by visiting http://hudhomesforsale.realtownblogs.com or by e-mailing the Author, Frances Flynn Thorsen, at Fran@TheREALTYgram.com HUD HOMES FOR SALE is a Guide that I recommend openheartedly. It is an e-book that provides the knowledge and tools necessary to develop and implement an intelligent HUD investment programme. I already have my own copy and for anyone interested in successful HUD investments, HUD HOMES FOR SALE is a Guide that will withstand the test of time.

Sunday, June 11, 2006

Estoppel Certificates

Real Estate ultimate weapon unveiled (wait until the Chinese read this Article). Written at a professional level especially for realtors, notaries and lawyers. Investors may want to take a look too, but are advised that no legal opinion is herein offered, rendered, inferred or otherwise implied.

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Estoppel, to the non-initiated, sounds more like the newest toy in the Pentagon’s vast array of secret weaponry and armaments, something that belongs more to Area 51 than the real estate world, or perhaps the latest scandal to permeate Capitol Hill. “CIA’s Probe Leak: The New Martin Lochheed F-22 Supersonic Estoppel!”, one might envision reading one day in the front page of USA Today. But readers of my Posts know better ...

In Real Estate, an “Estoppel Certificate” is a document signed by the Seller, under oath, confirming the representations made by the Seller in the Contract of Purchase and Sale. The reasons for the Buyer to request an Estoppel Certificate are twofold. First, to confirm the Seller’s representations as stated above and, secondly, to bar and prevent the Seller from later on asserting a fact, that is inconsistent with the terms of the Contract.

For instance, when purchasing a rental property – whether a house or an apartment building – an investor might want to insert the following two conditions precedent (‘subject to’ clauses). The first might read:

“Subject to the Buyer by ( insert date ) reviewing and approving the Residential Tenancy Agreement(s) presently in effect and covering the property herein bought and sold. Seller warrants that the term(s) of the tenancy is/are for a period of ( insert length of tenancy ), the monthly rent(s) is/are ( insert amount ) and that the last rental increase was on ( insert date )”.

What happens if, by the time all the subjects are removed (and the property is virtually sold) and the time the investor completes the transaction, the tenant is run over by a bus and dies? In some instances the market value of the subject property may be altered, as in the case of an investor purchasing a professional building. This is where an Estoppel Certificate fits in.

The second clause might read:

“Subject to the Buyer, after all the other subjects herein are removed but in no event before two weeks (or any other time) prior to completion and no later than one week (or any other time) prior to completion, receiving, perusing and approving an Estoppel Certificate ratified by Seller covering the existence and confirming the validity at law of the subject matter and terms of the tenancies herein. Failure by the Seller to provide such Estoppel Certificate in the aforesaid time-frame will render this Contract null and void, and all deposit monies until then paid by Buyer will be refunded to Buyer forthwith with interest accrued thereon, if any there be”.

The reason for Estoppel Certificates to exist in Real Estate is to be found in the equitable Doctrine Of The Promissory Estoppel. Under this doctrine, one party is barred and prevented from withdrawing a promise made to another party, if the latter has relied on that promise and acted upon it. All the more so, since contracts in real estate are made ‘under seal’ (deeds) and, as such, the rule of evidence arising from the special status of a deed is that the parties are expected to take greater care to verify the contents of the agreement and their validity at law, before consummating it.

The American Law Institute goes one step further by discerning between equitable and promissory estoppel in its Restatements of Contracts as follows:

“Equitable estoppel is distinct from promissory estoppel. Promissory estoppel involves a clear and definite promise, while equitable estoppel involves only representations and inducements. The representations at issue in promissory estoppel go to future intent, while equitable estoppel involves statement of past or present fact. It is also said that equitable estoppel lies in tort, while promissory estoppel lies in contract. The major distinction between equitable estoppel and promissory estoppel is that the former is available only as a defense, while promissory estoppel can be used as the basis of a cause of action for damages. The American Law Institute’s website can be found at http://www.ali.org.

All the foregoing simply goes to prove, once again, that the discipline of real estate wheeling and dealing is littered with rubbish all the way – until such time as a contract is entered into and ratified by the parties, at which time Real Estate suddenly becomes all too deadly serious.

Thursday, June 08, 2006

REIT: Real Estate For The Elite

With interest rates on the rise and real estate prices in strategic retreat, syndicates and trusts are going private once again, and managers are out in droves looking for deals.

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While real estate syndicates are formed for a variety of reasons, the typical reason is to create a tax shelter. More specifically, the purpose of a Real Estate Investment Trusts or REIT is to reduce or eliminate corporate income taxes. In the United States, where they are generally more widespread as investment vehicles, REIT pay little or no federal income tax but are subject to a number of special requirements set forth in the Internal Revenue Code, one of which is the requirement to distribute annually at least 90 percent of their taxable income in the form of dividends to shareholders.

The first REIT was introduced in the United States in 1960. The vehicle was designed to facilitate investments in large-scale income-producing real estate by smaller investors. The US model was simple, enabling small investors to acquire equity interests in vehicles holding large-scale commercial property. In order to ensure that REIT are widely held, they must have at least one hundred shareholders, no five or fewer individual shareholders can own more than 50 percent of the equity value of the REIT’s shares, and the REIT must be managed by one or more trustees or directors. At least 75 percent of the gross income of the vehicle must come from real estate related sources, and at least 95 percent of the REIT’s gross income must come from real estate related and other passive income sources.

To maintain competitiveness, many REIT have distributed in recent times among investors all or even more than their annualized earnings, often resulting in dividend yields comparable to bond yields. This is not, however, a practice that can be sustained for long even during times of appreciation of real capital assets and market values, much less when values are dropping. In fact, if an investment company such as a REIT distributes more than its taxable income, the excess distribution is considered "return of capital" for tax purposes, which is taxed to the individual investors as a capital transaction, rather than regular income. The end result is, therefore, that the distribution requirement may hamper a REIT's ability to retain earnings and generate growth.

Because of this, the shift to privatization is driven by the realization that private buyers will pay more for the company than stock market investors will. In addition, rising costs of being publicly-traded companies are another factor enticing REIT to pull out of the stock market. And finally, being private gives Real Estate Investment Trusts a freer hand to reach out for deals in an increasingly competitive market. The reason is that public companies find it very difficult to grow through acquisition, as investors invariably do not justify the risk of development alternatives. The combined power of reduced expenses, consolidated pools of capital and abating real property values are exactly the perfect recipe for making a kill in real estate – and they are doing it!

The inverse relationship between interest rates and prices of REIT’s shares plays a role as well. On average, it is safe to assume that interest rate increases are likely to be met by REIT’s price declines in the Stock Exchange, because increasing rates correspond to a slowdown in the economic growth and less demand. But out of the context of the frantic buy and sell of Wall Street, even slowdown in the market for single-family houses can actually benefit REIT. This is so, because even though real property prices are in decline, it is still cheaper to rent than to own, especially during a period of rising interest rates. And REIT thrive on rentals. No city is a better environment for REIT to operate in than New York City, where some 70 percent of residents rent.

Sunday, June 04, 2006

Real Estate Bubble Update: Where is the Flood of Foreclosures?

The Mortgage Bankers Association of America says foreclosures are at pretty much the same level this time last year.

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One of the many dire predictions done these past few months by many ‘bubbleologists’ out there - that is all those who indulge in the contemplation of real estate bubbles of all sizes and colors, whether real or imaginary, coming our way - was that by now real estate markets everywhere would be inundated and swept away by a tsunami of foreclosures of apocalyptic proportions.

The general rationale among those specializing in the fine art of staring at crystal balls (or perhaps at several empty bottles of rum) was that the steady increase in interest rates, the consequence of a tightening monetary policy implemented by the Fed since mid-2004, would have led by now to a collapse of the adjustable-rate mortgages (ARMs) market, since consumers could not possibly cope with the increased monthly payments. This, in turn, would dramatically increase mortgage defaults and foreclosures, with the end result that real estate markets everywhere would be flooded with excess inventory at deflated prices, thus causing markets to crash - the tsunami I was talking about.

The Mortgage Bankers Association of America (http://www.mbaa.org) does not seem to share this particular vision of the end of the world. In its Economic Outlook update released in May 2006, the Mortgage Bankers Association of America (MBAA) pegs the ARMs share at 27 percent, down from the 36 percent peak of early 2005, an indication that many prudent consumers have locked in already. Likewise, the inventory of mortgages held by banks is virtually unchanged at 1,500 billions (aggregate nominal face value of mortgages, by dollars), the same level of 2005, suggesting that, rather than defaulting, consumers are ‘holding on’. And, finally, the rate of delinquency is at 4.38 percent, down from 4.70 percent in the final quarter of 2005, clearly another measure of consumers financial stamina, and an indication that banks were actually faring worse when real estate markets were doing better.

But that’s not all!

In the Mortgage Finance Forecast released also in May 2006, MBAA highlights that the rate of housing starts nationwide has increased nationwide, up to 2,131,000 units (annualized) for the first quarter of 2006 from 2,059,000 units in the last quarter of 2005 – an increase of 72,000 units representing a robust +3.496 percent overall, although this rate is forecasted to slow down as the softening trend in real estate markets continues throughout the year. Home sales overall are forecasted to decrease by 501,000 units nationwide to 6,574,000 units by December, 2006 from the 7,075,000 of December, 2005. Although this represents an annualized drop in sales of 7.08 percent compared to last year, it can hardly be called a bubble burst!

And here is the most surprising figures of them all – surprising for the bubbleologists, that is. Notwithstanding the increase in interest rates and the toll that many think ARMs will take on defenceless consumers, MBAA forecasts that the average market share of ARMs will remain constant at 27 percent of institutional mortgages for 2006, down only 3% from the 2005 average. The significance of this forecast is twofold: 1) MBAA does not anticipate that interest rates will increase significantly higher for the remainder of the year and 2) MBAA mirrors a Gallup survey conducted in May 2006, which found that only 11 percent of Americans worry about ARMs, down from 20 percent in 2005.

And why should they worry? In the latest release, the Bureau of Labor Statistics, has pegged the Consumer Confidence Index at 109.6 in April, up from 107.5 in March and higher than the 103.8 of December, 2005. The Consumer Confidence Index is now at the highest level since March, 2002, with the average family income up 0.8 percent in March, 2006.

To finish, I would like to spend a few words on how politics are filtering into economics, especially in times of elections. It is a shame that an increasing number of Bloggers and even journalists out there are twisting and interpreting economic data to fit their own political agenda. Although November, 2006 is pretty much around the corner and the battle is on to take control of Congress, the manipulation of economic and statistical data for political ends and means is a great disservice to consumers, no matter the political colors.

For example it is not true, like some Bloggers assert out there, that the recent appreciation in real property values is the direct result of President Bush’s domestic economic policies. Real estate capital growth was largely due to the correlation between capital and employment or, if you will, between income and labor. An increase in levels of consumption has set forth an increase in prices caused by a corresponding increase in demand, in itself generated by a commensurate increase in the income-employment factor. So growth was derived by the equilibrium of capital and investment with labor and employment. And since, furthermore, production is in direct function of consumers spending which increases as unemployment falls, capital accumulation has increased as employment rose steadily. It is as simple as that!

Likewise, it is not true that President Bush is the main culprit for the real estate bubble burst – like many Democratic sources imply and some actually cry out loud. Poor President Bush has absolutely nothing at all to do with real estate bubbles and their bursts, essentially for two reasons: 1) because there are no bubbles in real estate and 2) because there are no bursts either. Like Prof. Bernanke has repeated now several times, far from being a bubble burst the present cooling-off trend through higher interest rates will have the beneficial effect of consolidating market wealth achieved thus far, by allowing the economy to get an even footing through a slowdown of capital appreciation and, at the same time, allowing real wages to catch up, thus reducing the affordability crisis and rejuvenating the pool of buyers.

And, finally, it is not the President of Iran, Mahmoud Ahmadinejad, that is trying to promote his country’s nuclear programme by putting a stranglehold on North America’s real estate markets through higher crude prices, while attempting to get rid of Secretary Rice at the same time (I know, this is laughable, but I read it in the commentary of a political blog – TIME Magazine should make this particular blogger ‘Man of the Year’).

Consumers and all those interested in an objective evaluation of real estate markets climate, are well advised to go straight to the source of statistical data and economic analysis and evaluation, bypassing all commentaries entirely, especially these days.

Thursday, June 01, 2006

Selling Or Refinancing?

Which is the best option for indebted real estate consumers? Read on ...

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When you last went shopping for a mortgage you found yourself facing an array of options, from a six-month ‘open’ to a 10-year ‘closed’ and everything in between. And chances are you did not quite grasp or paid attention to the differences among all those many options, mostly because you never envisioned a time of interest rates increase. Now that the tide is changing, of course, the basic question becomes the most important: which option is the best to minimize mortgage costs?

As markets are progressively cooling off as a direct and proximate result of the monetary policies of the central banks, property owners with financing on a variable scale are facing rising interest costs. This fact calls into question whether it is preferable to sell outright, or if it makes more sense to refinance and stay put. Selling may not necessarily be the easy way out, particularly for those who bought in recent years, when the market was entirely different, and ended up paying premium prices, in several instances over and above asking prices. As real estate markets in many areas are now going through a period of value adjustment and wealth consolidation, it may not be possible to recoup the high prices paid only a few months ago. On the other hand, the good news is that lenders are rolling out a host of inducements to attract new borrowers and to keep existing homeowners from paying off their loans.

One such example is the introduction of a new home-equity loan product with a rate that is fixed for 20 years, and which is typically offered at half a percentage point below the standard rate on regular home-equity lines of credit. Other banks are offering enticements to keep customers who are worried about rising rates from paying off their home-equity lines of credit. These banks seem to target those borrowers who previously paid off their home-equity lines or seemed likely to. And yet, other institutional lenders are beginning a program that gives existing customers the option of continuing to make interest-only payments on their home-equity lines of credit, while setting a fixed rate on some or all of the outstanding balance.

Home-equity lending has boomed in recent years as record numbers of consumers have taken advantage of low rates and rising home values to fund their spending needs, or to pay off high-cost debts. Borrowing against home values added $600 billion to consumers' spending power last year, according to Federal Reserve calculations, with about one-third of that sum coming from home-equity loans and lines of credit. But rising short-term interest rates have put a damper on the rapid ascent of the home-equity market. The value of home-equity lines of credit at commercial banks increased 17 percent in September over the previous year, according to the Federal Reserve. That was well below the 45 percent annual growth rate seen last fall. On a month-to-month basis, home-equity line balances, which totaled $438.7 billion at the end of September, have been basically flat since the end of July [source: http://www.federalreserve.gov].

The surge in home-equity borrowing has been driven mainly by the rising popularity of home-equity lines of credit, which give homeowners the right to borrow up to a certain amount, either all at once or as needed. Home-equity loans provide borrowers with a lump sum and a fixed rate. But rising interest rates have made home-equity lines of credit less attractive than they were as recently as the summer of 2004, when the prime rate was just 4 percent. What's more, the rate difference between a home-equity line of credit and a fixed-rate loan has narrowed, because short-term market rates have risen faster than long-term rates. And as rising rates begin to pinch borrowers' pocketbooks, the number of homeowners paying off their credit lines has increased. In fact, industry sources reveal that the number of borrowers prepaying their credit lines has climbed 50 percent this year compared to the same period in 2005. As a result, some borrowers are opting for more predictability.

Lenders, moreover, have introduced new features that allow borrowers to lock-in the rate on some or all of their credit line. Fixed-rate home-equity loans typically make more sense for borrowers who have a one-time need for cash, such as paying off credit-card debt or consolidating existing auto loans. A home-equity line, on the other hand, can be a better choice for someone who needs the money over time, for example, to pay college tuition fees or fund a long-term remodeling project. That's because borrowers pay interest only on the money they have actually drawn from the line of credit. They also can elect to make interest-only payments during the early years.

In essence, if selling is not a viable option, there are basically four approaches to follow so as to minimize costs in the wake of rising interest rates:

[ ] Home equity lines of credit.

They still make sense for borrowers who do not need cash all at once. Though vulnerable to higher interest rates, the borrower only pays interest on the amount of money actually drawn out.

[ ] Fixed-rate options on home-equity lines.Allow borrowers to lock-in the rate on some or all of their line of credit. This can provide a hedge against rising rates, while maintaining a borrower’s ability to tap the credit line as needed.

[ ] Home equity loans.Provide borrowers with a lump sum and a fixed rate. Borrowers are protected against rising interest rates, but must pay interest on the full loan amount even if they spend only a portion of the money.

[ ] Cash-out refinancing.Allows borrowers to pull out extra cash when refinancing the mortgage. Whether this makes sense depends in part on the rate of the existing mortgage and the cost of refinancing.